VC Screening Criteria

There are many factors that exist by which venture capitalists will use to screen the investment potential of your company. By understanding such factors, companies can better prepare for questions that may be asked and structure the business around such criteria early on to potentially increase its probability of success.

As you will see, there are many factors that must be considered aside from the business plan that Pro Business Plans cannot directly help with. The company is readily available to provide financing advisory for its existing client base, but many of these screening criteria are exclusive to your business model and fundamental changes may need to be made in order to increase the chances of success in not only the financing marketplace, but also the potential long-term profitability of your company. This blog post is dedicated to communicating the screening criteria applied by venture capitalist groups at a brief level.

1. Management Team

When investors review the management team of a company, they are searching to determine whether or not they are capable of running the company. In some cases, people that are not qualified to run a company manage to produce a profitable product.

Because this has historically been the case, founders are often removed from leadership positions soon after a professional investment group is introduced. However, in most circumstances, the existing management team will need to bring the company to a point in which third-party management may be acquired. Moreover, the management team often quickly communicates the sophistication of the market solution proposed by the prospective company.

If a senior engineer at healthcare company produces an advanced health screening technology, it is likely to be taken more seriously than a newcomer with no experience in the healthcare sector. Having a strong management team is a reason to analyze prospective investments in more detail, as investors assume that those who have had success in the past are likely to replicate it in the future.

2. Business Model

A company’s business model is what fundamental market problem that it addresses and how it anticipates to profit from its solution. Although some companies have received financing without a fundamental revenue strategy, lack of a clear path towards profitability means that there is a chance investors will never have their money returned.

There are few things more frightening to investors than the loss of their money and nothing makes them more evasive than a business model that fundamentally lacks any revenue generation potential. The best approach to avoid this situation is to choose to enter markets that have profitable potential or at least determine a clear path to profitability before presenting anything to investors.

3. Geographic Location

In some cases, the geographic location of your business will determine whether or not an investor’s fund permits him/her to invest in your company. Statistically, most venture capital funds are directed to the United States, namely the San Francisco and New York metropolitan areas.

The geographic location is also important to investors because it typically dictates what resources that the entrepreneurs in the market. A startup located in a dense urban area is more likely to have a wider access to a talent pool, strategic partners, and professional advisers than one in a highly rural area.

4. Competitive Advantage

Perhaps the most important consideration when screening an investment is its competitive advantage. A competitive advantage can be either political, such as market protection through patents or permit restrictions or artificial through branding or product positioning.

For instance, the Coca Cola brand has a strong competitive advantage because of the reputation that its brand has established in the market relative to new soft drink producers. The competitive advantage of Pro Business Plans is that it is owned by a larger consulting firm, which means that you can yield the same resources as large companies with an international presence, while not being being charged the outrageous retainer fees as boutique investment banks.

5. User Metrics

With an increasing number of startup companies entering the market, VC firms have been able often filter through companies that have already generated traction. There are many types of traction that a startup company can attain such as business model validation, the ability to scale, and profitability which are presented below:

i. Validation – This is the earliest and most basic form of validation and will likely not be sufficient for many investors. This is comprised of Beta users (paying or not) that are insufficient to support your service or product. Important metrics would be the number of bottom-line users or even purchase intent agreements if you are working with enterprise customers. This leaves investors weary because they must ‘trust’ that these customers will stick, more will come, and it will be profitable.

ii. Ability to Scale – The ability to scale demonstrates that the Beta users have not just adopted your product, but are likely to continue using it in the future. Take for instance Facebook, that gained traction outside of the campus environment. If the social platform only worked for universities, then its ‘validation’ metrics would have been false indicators of its potential.

Examples for this include new user growth, diversification of the customer base, and a return or active rate – rather than just downloading an app and registering and not staying engaged. This is often the ‘sweet spot’ of investment because its common practice for many companies to ‘scale’ without being ‘profitable’ while they onboard users and thwart competition. A classic example is Twitter, which successfully raised multiple rounds without a single paying user. Another recent example is Venmo, a mobile app that functions as a free money transfer service.

iii. Profitability – First, it is important to clarify there is often a ‘leap’ that occurs between ability to scale and profitability. Many platforms that have an enormous amount of users still lose money. They may still profit from users, but they spend more money acquiring them and/or delivering the profit than their spread. Most startup companies are not expected to be profitable.

After all, investors are speculating about the future position of the company and one investing in growth only needs to reduce is marketing spend to capture more revenue as has been proven by countless cases such as Netflix, Amazon, PayPal and many more. Most investors believe that as long as you have users, as a worst case, you can sell your user base to a third-party.